29 Jun Ham-fisted Naspers and Prosus serve their shareholders baloney
As published in Business Day on 23 June, 2021 by Pieter Hundersmarck
Overshadowing any operational result from Naspers and Prosus is the increasing concern around capital allocation and management incentives that have destroyed shareholder value for over a decade. These concerns, along with the cross-shareholding and control structures, are the primary drivers of the Naspers and Prosus share price discounts.
Let’s use Prosus as an example. As of May 31 2021, its 29% stake in Tencent was worth USD 204bn. The Net Asset Value (“NAV”) of its e-commerce portfolio excluding Tencent is valued at USD 39bn. Prosus’ current market capitalisation is USD 158bn, or USD 85bn less than its stake in Tencent and its estimate of its e-commerce portfolio.
In a stinging rebuke, the market has attributed a negative value of USD 85 bn to the control structure and the entire management team at Naspers, a discount that has worsened over the last decade.
Despite showering their executives with enormous sums of money and investing in a swathe of random high-growth internet businesses, the discount remains stubbornly high.
How do Naspers justify their poor performance when they own a piece of one of the largest and most valuable companies in the world? And what do they tell themselves are the reasons? Perhaps they need a few reminders.
1. There are ways to close the discount, but it’s clear that management isn’t incentivised to pursue them.
The fact that Naspers treats its shareholders poorly is well known. This is particularly true when it comes to discussions around the discount to NAV. At Flagship, our 30 years of cumulative focus on global investing has provided us with many relevant examples against which to compare Naspers’ current predicament, as well as its potential solution.
Kinnevik, a Swedish family-owned holding company, is one such example for Naspers to emulate when it comes to understanding capital management and fair treatment of its shareholders.
Kinnevik first invested in fast-growing German e-commerce company Zalando in 2010 and successfully listed it in 2014. Zalando’s strong execution created significant value for Kinnevik’s shareholders – from a total investment of SEK 7.9bn, Kinnevik’s stake by 2020 was worth SEK 55.1bn, generating a nearly 7-fold return. It formed a large part of Kinneviks NAV. Sound familiar?
Kinnevik management had two options. It could continue to post gains on the performance of a listed company that shareholders could easily access themselves (Zalando) and make its management team indecently rich by rewarding them for that performance (sound familiar?). Or it could distribute Zalando shares to its shareholder base, allowing them to decide what they wanted to do with the shares.
Kinnevik chose the latter. By distributing Zalando, management could focus on faster-growing opportunities that their investors couldn’t access elsewhere while avoiding the fate of a holding company discount that has plagued Naspers.
The result? Kinnevik has trounced Naspers over five years, returning 258% for shareholders versus 109% for Naspers. Kinnevik even outperformed Tencent’s remarkable 229% return over that period.
Kinnevik chose not to make management rich at the expense of their shareholders. More importantly, they chose to stick with what they know – investing in growth companies – rather than being passive holders of a listed company to which it could add zero value.
In contrast to Kinneviks approach, Naspers claims that they can’t distribute Tencent because of capital gains tax. This point is now moot: given the massive underperformance of Naspers versus Tencent over all time periods, a 20% tax on their disposal into a holding company listed on the JSE would have been value accretive for all shareholders at nearly any point in the last 15 years.
That knowledge must surely sting. But it doesn’t seem to have any effect on management. Why is this the case? Because Naspers operates as a different kind of investment (or venture capital) company.
In a normal (or ‘real’) venture capital company, the managing investors enjoy ‘carried interest’ on the funds they manage, as well as a payout if they manage to invest wisely. The payout comes through the ‘exit’ when the asset is listed or sold at the end of the investment period. The sale is proof of the success of the venture.
Naspers is one of the few listed businesses that seems to buck this trend, levying handsome rewards from all its loss-making operating companies before their success has been proven. Although the accounts are hellishly difficult to fathom, I guess that the total remuneration for Naspers management currently sits at north of USD 3bn, versus an ‘independent’ value of their e-commerce portfolio of USD 39 billion, from USD 16 billion invested.
If their USD 39 billion portfolio value is to be believed (in a time of sky-high asset prices), then management will be set to earn USD 3bn from USD 23bn of ‘value creation’. This is 13% of the growth in “value”, while the share price reflects a discount to Tencent, meaning none of that ‘value creation’ accrues to shareholders.
This is a hedge fund-like remuneration structure based on management’s ‘assessment’ of value creation when the entirety of the global stock market disagrees with them and believes there has been value destruction. The result? Management is the only one gaining, and shareholders bear all the losses.
2. The market index, what it looks like and how it is constructed should be none of Naspers or Prosus’ concern.
In a recent interview with Daily Maverick, CEO Bob van Dijk stated, “We have outperformed SWIX for years, and so are 30% of the index. We will continue to outperform it, and if we sat back and did nothing, we would become 50% of the index, and that would be irresponsible”.
Did everyone just get that? Bob believes it is irresponsible to increase the share price because Naspers and Prosus may get too big in indices. To whom does Bob owe this “responsibility”? Surely Bob should be saying that his responsibility is to his shareholders, and his job is to increase the share price?
While sharing his responsibility to the ‘index’, Bob simultaneously says he wants the discount that Prosus and Naspers trade at to close (which would raise the share price and its size in the index). So, which is it, Bob?
In the same Daily Maverick interview, Bob continues, “I have been called arrogant and tone deaf, but Basil [Sgourdos] and I have probably had 300 to 400 conversations with shareholders in recent weeks.”
Here we can only logically point out that if you have had 300 conversations with investors and the discount remains, then your mission has utterly failed. One wonders how Bob thinks discounts close. Or perhaps his shareholders weren’t speaking in the right tone?
3. Naspers management competence in buying or building internet businesses is shaky at best.
Besides Tencent and one or two other minuscule wins like Avito, Naspers hasn’t shown themselves to be good investors. And this is exactly what the share price – the market – is saying.
It’s well known that Prosus’ main capital absorber (food delivery) has poor unit economics, and the risks (considering Uber’s latest regulatory mishaps) are not low. Its classified businesses are under heavy attack from Facebook and other well-funded competitors. As an example, let’s look at one of their latest investments in more detail.
Prosus’ current focus is filling its education (ed-tech) vertical, which is a nice way of saying they like the theme and will pay up for any exposure to it. It recently acquired 100% of the online learning platform Stack Overflow for $1.8bn from the company’s founding venture-capital investors, including Union Square Ventures, Index Ventures, Andreessen Horowitz, Bezos Expedition, Spark Capital, Silver Lake and GIC.
According to Pitchbook, Stack Overflow had its series D funding round (meaning its fourth funding round) in 2018, valuing the business at $459 million. Its Series E round was done for $85m in July 2020 – a mere 11 months ago – at a suspected $800m valuation.
A Series E funding round typically means one of two things: either you are doing extremely well or your business is drowning, and you need a lifesaver. A business that is doing really well typically raises much more than $85m.
Its main revenue driver is Stack Overflow for Teams, which generated $27m in 2020, or about a third of its total revenue of c.$80m. Prosus bought 100% for…. $1.8 billion? That’s 22x sales for a company that has been around since 2008 and is still raising capital 12 years later.
Furthermore, the sellers of Stack Overflow are some of the best and brightest investment minds on the planet. What exactly does Prosus believe it sees that Andreessen Horowitz and Silver Lake didn’t see? Or, put differently, who do you think got the better side of this trade?
4. Naspers should be an ESG standard bearer amongst South African corporates. Instead, it is amongst the worst.
South Africans have been poorly served by their corporate sector in the last few years. Steinhoff, Tongaat, Ascendis, Sasol, EOH, and a slew of other businesses have either misallocated capital or mislead investors. Their share prices, and the value of South African’s hard-earned retirement capital, have been decimated. Each of these corporates demonstrated a clear lack of ethics, each fraudulent in their own special way.
Naspers seems hell-bent on destroying value. It ignores its shareholders, presses ahead with an archaic control structure, invests in a swath of random businesses that it has questionable expertise with, all while its executives enjoy massive remuneration packages. In the meantime, the shareholders pay the price.
Thirty-six of South Africa’s best asset managers – with the shameful exception of the largest three – took the unprecedented step of writing to the Naspers board about their poor track record and their latest control structure machination. Naspers’ response is that it will be proceeding regardless.
Is there a way of measuring how much value has been destroyed? Yes. South African unit trusts have been able to invest directly offshore for many years and could easily have bought Tencent directly instead of Naspers.
Those that believed the empty management promises to close the discount and remained invested in Naspers have paid a high price.
Tencent has delivered a share price return of 39.86% per annum in the ten years to May 31, 2021. Naspers has delivered 28%. Had you invested a million rand in Tencent in May 2011, you would have R28.6 million today. You would have R11.8 million had you invested in Naspers.
But it gets worse. This is not just a theoretical exercise. Even if you didn’t make the conscious decision to invest in either company, your retirement funds were probably heavily invested in Naspers. The entire retirement industry has borne this cost.
The point here is not that there are always better investments; the point is that this outcome was completely avoidable if the right management and incentives were in place.
ProSus, founded in 1985, is a ham maker in Italy. The name is a colloquial way to say “prosciutto”. Its namesake, a glorified management enrichment scheme listed in Amsterdam, seems to believe its shareholders are only worthy of far cheaper baloney, rather than the more expensive prosciutto.
And, unfortunately, many of the custodians of the retirement funds of hard-working South Africans seem to share that view.
About Pieter Hundersmarck:
Pieter is a fund manager and member of Flagship’s global investments team.
Pieter has been investing internationally for over 13 years. Prior to Flagship, he worked at Coronation Fund Managers for 10 years in the Global and Global Emerging Markets teams, and also co-managed a global equities boutique at Old Mutual Investment Group. Pieter holds a BCom (Economics) from Stellenbosch University and an MSc Finance from Nyenrode Universiteit in the Netherlands.